Lehman Brothers - Leverage Analysis - Stanford …jbulow/Lehmandocs/docs/DEBTORS...l .. EHMAN BROTHERS April 7, 2008 Erin Callan Lehman Brothers - Leverage Analysis FOIA CONFIDENTIAL

l .. EHMAN BROTHERS April 7, 2008

Erin Callan

Lehman Brothers - Leverage Analysis

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS, INC.

Confidential Presentation

LBEX-DOCID 1401225

Overview + Leverage for the industry and for Lehman Brothers has increased significantly and has been a key

driver of improved profitability.

- Starting from a high level, Lehman's net leverage has increased less than its peers in the past five

years

- Growth in assets primarily fuelled by a rapid growth in equity

+ Lehman's return on assets has been above average but significantly below that of Goldman Sachs

+ Lehman's growth in net balance sheet has been weighted toward mortgages and loans.

- Deleveraging will require selling these assets, which will result in losses for Lehman

- Additionally, Lehman has grown the matched book and rates business, which are now outsized

relative to Firm's size, and have inflated gross balance sheet

+ Leverage can be thought of as both a reflection of market risk and refinancing/liquidity risk.

- Refinancing risk is mitigated by having a more stable liability structure: customer deposits and long term debt vs. commercial paper, repos and free credit balances from hedge funds

- Reducing leverage is necessary to remove refinancing risk and win back the confidence of the market, lenders, and investors.

LEHMAN BROTHER.S


1

LBEX-DOCID 1401225

Average Industry Leverage Ratios - 2000 to 2007 + From 2000 to 2007, both gross and net leverage for the industry increased by approximately 30% on

average. Gross leverage increased further in 1 Q08 for Lehman, although net leverage was reduced.

35.0x

30.0x

25.0x

20.0x

15.0x

IO.Ox

5.0x

O.Ox

2000 2001 2002

Gross

Net

24.0x

13.7x

24.9x

13.7x

24.lx

13.3x

(!)Bear Stearns' net leverage ratio is excluded from the average for 2000.

LEHMAN BROTHER.S


2003

22.4x

12.9x

2

2004

24.0x

13.4x

2005

25.3x

13.9x

2006

26.4x

14.5x

2007

31.2x

18.0x

1111111 Average Gross Leverage Ratios

D Average Net Leverage Ratios

LBEX-DOCID 1401225

Industry Revenue Growth in Capital Markets + Leverage has driven profitability in capital markets businesses

- Balance sheets expanded to capitalize on opportunities and capital markets revenues grew along with the asset base

- Intra-quarter, even Lehman's gross balance sheet is regularly above $1 trillion

$1,200 $1,120 $5,000 $1,045 $1,020

$900 $4,000

$691 $3,000

$600 $395 $2,000

$300 $1,000

$0 $0

GS MS MER LEH BSC 2003 2004 2005 2006 2007

••• 2000 ii 2007 ••••••••••••••••••• Total Assets ~Balance Sheet Intensive Revenue

$120

$100

$80

$60

$40

$20

$0

Source: SNL Financial, Company reports, Lehman Brothers Estimates

LEHMAN BROTHER.S


3

LBEX-DOCID 1401225

Industry Asset Returns In Capital Markets + Asset profitability never really improved - there were just more assets to trade. This does hide the

significant disparity between the different firm's which reflects both rate of turnover of assets, and the underlying riskiness of those assets

LEHMAN BROTHER.S


4 Source: SNL Financial, Company reports, Lehman Brothers Estimates

LBEX-DOCID 1401225

Competitor Leverage Analysis + Over the past few years, Lehman Brothers gross leverage (based on a 5 quarter average of

leverageable equity and total assets) is consistently at the high end of the peer group.

+ After initially declining, Lehman Brothers net leverage (based on a 5 quarter average of leverageable equity and net assets) has crept back towards the higher end of the peer group in recent years, signaling higher risk.

} !l

2003 2004 2005 2006 2007 2003 2004 2005 2006 2007

Lehman Brothers 10,240 11,665 14,175 17,218 21,041 153,503 171,353 191,646 237,510 327,492

Goldman Sachs 15,209 20,402 23,785 28,719 37,244 208,228 243,869 321,186 413,749 545,694

Morgan Stanley 23,946 27,795 28,877 33,011 36,895 296,239 343,295 366,584 460,077 584,411

Bear Steams 7,140 8,062 9,664 11,401 12,576 91,877 108,583 149,705 184,697 243,771

Merrill Lynch 23,361 27,525 29,874 35,357 38,543 332,897 380,573 412,718 440,195 561,525 ...............................................................................................................................................................................................................................................................................................................................................................

2003 2004 2005

Lehman Brothers 28.0x 24.0x

Goldman Sachs 19.2x 20.2x

Morgan Stanley 24.7x 26.lx

Bear Steams 29.7x 29.lx

Merrill Lynch 18.7x 18.6x

LEHMAN BROTHER.S


23.7x

23.7x

28.8x

28.2x

19.6x

2006

25.4x

24.7x

31.3x

27.9x

20.6x

2007 2003 2004 2005 2006 2007

28.9x 15.0x 14.7x 13.5x 13.8x 15.6x

25.2x 13.7x 12.0x 13.5x 14.4x 14.7x

32.0x 12.4x 12.4x 12.7x 13.9x 15.8x

30.9x 12.9x 13.5x 15.5x 16.2x 19.4x

25.9x 14.2x 13.8x 13.8x 12.4x 14.6x

5

LBEX-DOCID 1401225

Revenue Return on Assets - Competitor Comparison + Comparing Capital Markets revenues (revenues adjusted to exclude IMD and IBD below) to net assets I

shows that Goldman Sachs consistently delivered the highest returns with Lehman immediately behind

+ Asset productivity declined rapidly in 2007 because of the dependence on residential and commercial mortgage asset turnover. Relative spreads (yield on assets vs. financing) will partially offset the slowdown in turnover for assets held.

Lehman Brothers 8,647 11,576

Goldman Sachs 16,023 20,951

Morgan Stanley 20,817 23,708

Bear Stearns 5,994 6,813

Merrill Lynch 19,900 22,059

2003 2004

Lehman Brothers 5.6% 6.8%

Goldman Sachs 7.7% 8.6%

Morgan Stanley 7.0% 6.9%

Bear Stearns 6.5% 6.3%

Merrill Lynch 6.0% 5.8%

LEHMAN BROTHER.S


14,630

25,238

26,778

7,411

25,277

2005

7.6%

7.9%

7.3%

5.0%

6.1%

17,583 19,257

37,665 45,987

33,858 30,012

9,227 5,945

33,781 11,250

2006 2007

7.4% 5.9%

9.1% 8.4%

7.4% 5.1%

5.0% 2.4%

7.7% 2.0%

6

tr !

2003 2004 2005 2006 2007

6,018 7,694 9,807 12,006 12,257

11,459 15,024 18,611 27,742 33,942

12,203 13,347 15,375 20,665 12,356

4,702 5,362 5,901 7,311 4,062

7,519 7,838 9,390 16,017 (7,690)

2003 2004 2005 2006 2007

3.9% 4.5% 5.1% 5.1% 3.7%

5.5% 6.2% 5.8% 6.7% 6.2%

4.1% 3.9% 4.2% 4.5% 2.1%

5.1% 4.9% 3.9% 4.0% 1.7%

2.3% 2.1% 2.3% 3.6% -1.4%

Note: Morgan Stanley's revenue includes Discover Financial Services to keep the data consistent for the metrics.

LBEX-DOCID 1401225

Lehman Brothers- Balance Sheet (Assets) Growth + Lehman Brothers gross leverage has increased 34% since the end of2003.

Principally in matched book and rates businesses (especially short positions - which shows in reverse repo balances and gross balance sheet).

+ The change in Net Leverage is small, but weighted towards illiquid assets like mortgages and loans ASSETS

Cash and Cash equivalents Cash and securities segregated and on deposit for regulatory and other purposes

Government & Agencies Commercial Paper & Other Money Mkt Instruments Physical Commodities Mortgage and Asset-Backed Securities & Real Estate Corporate debt and other Corporate equities Derivatives and other contractual agreements Inventory Subtotal

Securities received as collateral

Securities purchased under agreements to resell Securities borrowed Collateralized Lendings Subtotal

Receivables Subtotal

Other

TOTAL ASSETS

Cash and securities segregated and on deposit for regulatory and other purposes Collateralized Agreements Identified intangible assets and goodwill

NET ASSETS

Stockholders Equity Leveragable Equity

Gross Leverage Net Leverage

LEHMAN BROTHER.S


7

Q4 '03

7,922 3,100

31,666 4,287

38,957 20,069 22,889 15,766

133,634

3,406

87,416 51,396

138,812

15,310

9,877

312,061

(3,1 00) (142,218)

(3,561)

163,182

13,174 10,681

23.7x 15.3x

Ql '08 %6

7,564 -5% 16,569 434%

44,574 41% 3,433 -20%

169 N/A 107,171 175%

59,581 197% 56,118 145% 55,612 253%

326,658 144%

N/A

210,166 140% 158,515 208% 368,681 166%

52,399 242%

14,164 43%

786,035 152%

(16,569) 434% (368,681) 159%

(4,112) 15%

396,673 143%

24,832 88% 25,696 141%

31.7x 34% 15.4x 1°/o

LBEX-DOCID 1401225

Illiquid Assets + Lehman Brothers Illiquid assets, as measured by Level III assets, are broadly in line with the rest of the industry.

220% 225%

n.a.

LEH MS GS MER LEH MS GS MER LEH MS GS MER LEH MS GS MER

Q2 2007 Q3 2007 Q4 2007 Q12008

iiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiii iiiiiiiiiiiiiiiiiiiiii~~l¥¢l.i~iii.$.$¢,($ii .. $iii.#:ii~~~~~i·iii.$.$¢,($ii~i~ii~iiQ~i!!!!iiiiiiiii~~Q$]iiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiii 8%

n.a.

LEH MS GS MER LEH MS GS MER LEH MS GS MER LEH MS GS MER

Q2 2007 Q3 2007 Q4 2007 Q12008

Source: Company filzngs. 1 OQs and earnzngs announcements. 1. Based on GS Q1 2008 approxzmate total assets of$1.2 trzllzon taken from earnzngs call transcrzpt.

LEHMAN BROTHER.S 8

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LBEX-DOCID 1401225 LEHMAN BROTHERS HOLDINGS, INC.

Illiquid Assets + However, the industry is more balanced in less liquid asset classes where as the composition of Lehman's

Level III assets are more weighted to residential and commercial loans versus corporate loans and private equity investments at Morgan Stanley and Goldman Sachs

100%

90%

80% 19%

70%

60%

50%

40%

30% 60%

20%

10%

LEH

LEHMAN BROTHER.S


Composition of Level III Assets

26%

23%

GS MS

9

71%

BSC

111111 Investments (MS only)

D Derivative assets

D Corporate equities

D Corporate debt and other

DMortgages

LBEX-DOCID 1401225

Lehman Brothers - RROA by Business + RROA by business shows a significant spread of returns by asset class over time and enables us to see I

where balance sheet growth was beneficial and detrimental over the past 4+ years.

Net Balance Sheet

FY 2003 Q1 '08 Total FID 108.1 259.5

FID Core 106.8 248.1 Int Rate Products 22.2 52.0 High Grade 11.2 11.3 Emerging Markets - -CDO 1.6 11.0 PassThru - -Real Estate 20.2 65.0 Securitized Products 37.2 62.1 High Yield 2.4 14.6 Munis 2.9 9.5 Commodities - 3.7 Foreign Exchange 1.6 6.3 FID Corp 6.2 2.2 FID Corp Loans 0.8 3.3 Invest Banking Loans 0.4 7.0

FID Prime Services 1.3 11.4 Total Equities 38.2 86.0

Equities Core 21.4 48.8 Exec Svcs I Lq Mkts 2.1 9.3 Convertible Products 2.6 2.7 Volatility 11.2 29.2 Equity Strategies 2.6 4.2 Firm Relationship Loans 0.8 2.8 Equity Corporate 2.3 0.5

Equities Prime Services 16.7 37.2 Principal Investing 3.2 14.7 IMD 1.9 13.7 Non Core 11.8 22.9 I Total Net Balance Sheet 163.2 396.7

SHADOW PRIME SERVICES

Total FID Prime Services (Net): 1.3 11.4

Total Equities GCS Prime Services (Net): 16. 7 37.2

TOTAL PRIME SERVICES NET 18.1 48.6

LEHMAN BROTHER.S


Gross Balance Sheet

FY 2003 Q1 '08 220.6 498.9 151.3 366.8 50.4 154.0 17.2 14.6 - -1.8 11.2

- -2l.l 65.7 43.8 65.1

3.1 16.2 3.0 10.2 - 4.0 1.6 6.4 7.4 9.1 l.l 3.3 0.7 7.0

69.3 132.1 66.2 188.8 28.0 60.4

2.4 14.9 3.0 3.3

14.3 33.2 2.8 5.4 1.0 2.8 4.5 0.8

38.2 128.4 3.4 16.7 7.1 17.0

14.9 64.6 312.1 786.0

69.3 132.1

38.2 128.4

107.4 260.5

10

Revenue RROA (Net Assets) RROA (Gross Assets)

FY 2003 Q1 '08 FY 2003 Q1 '08 FY 2003 Q1 '08 5,064.7 978.3 4.7% 1.5% 2.3% 0.8% 4,666.1 611.0 4.4% 1.0% 3.1% 0.7% 1,16l.l 1,000.8 5.2% 7.7% 2.3% 2.6%

686.4 665.9 6.1% 23.5% 4.0% 18.2% - - N/A N/A N/A N/A

232.6 50.5 14.2% 1.8% 13.3% 1.8%

- - N/A N/A N/A N/A 451.9 (1,226.5) 2.2% -7.6% 2.1% -7.5%

1,369.8 (270.9) 3.7% -1.7% 3.1% -1.7% 609.3 441.3 25.3% 12.1% 19.8% 10.9% 471.1 (206.1) 16.1% -8.7% 15.5% -8.1%

- 52.4 N/A 5.6% N/A 5.2% 127.9 208.3 8.0% 13.1% 8.0% 13.1%

(444.1) (104.7) ·7.1% -18.7% -6.0% -4.6% - - 0.0% 0.0% 0.0% 0.0% - - 0.0% 0.0% 0.0% 0.0%

398.6 367.3 29.8% 12.9% 0.6% 1.1% 2,005.6 1,414.9 5.3% 6.6% 3.0% 3.0% 1,626.3 1,127.3 7.6% 9.2% 5.8% 7.5% 1,129.8 850.9 54.8% 36.7% 46.2% 22.9%

213.3 23.3 8.4% 3.4% 7.1% 2.8% 197.5 352.1 1.8% 4.8% 1.4% 4.2% 115.2 13.8 4.4% 1.3% 4.2% 1.0%

- - 0.0% 0.0% 0.0% 0.0% (29.5) (112.7) -1.3% -83.1% -0.7% -53.2% 379.3 287.6 2.3% 3.1% 1.0% 0.9% 628.4 211.6 19.7% 5.8% 18.8% 5.1% 187.6 (125.4) 9.9% -3.7% 2.7% -3.0% 760.6 1,027.2 6.4% 18.0% 5.1% 6.4%

8,647.0 3,506.6 5.3% 3.5% 2.8% 1.8%

398.6 367.3 29.8% 12.9% 0.6% 1.1%

379.3 287.6 2.3% 3.1% 1.0% 0.9%

777.9 654.9 4.3% 5.4% 0.7% 1.0%

LBEX-DOCID 1401225

Growth in Leverageable Equity + Growing our equity base faster than our peers will reduce leverage and put us on a more level playing I

field from an absolute perspective.

+ Absolute size of capital is important for ratings and the perception of stability with lenders and investors. We are now around 75% of the size of our peers, on average, post convert.

26.5

23.2

12.6 10.9

2003 2004

IIIII Lehman Brothers

D Competitor Average 2

LEHMAN BROTHER.S


CAGR ('03- '07) CAGR ('03- 01 '08 Pro-forma)

Lehman 21% Lehman 27%

Competitor A vg. 11% Competitor A vg. N/ A

36.6 35.1

29.0 1

29.7

15.6

2005

23.1

18.6

N/A

2006 2007 Q12008

1. Lehman QJ "08 equzty number has been adjusted to znclude $4B resultzngfrom the convert issuance

11 2. Represents the average of Goldman Sachs. Merrill Lynch. and Morgan Stanley. Equity

numbers are based on Lehman "s definition ofLeverageable Equity and may not match the competitors reported numbers

LBEX-DOCID 1401225

Costs of De leveraging + Expected losses from reductions are around 3. 5% on average

- $22B of illiquid assets will cost us ~$7 50mm

$ in millions

Real Estate Residential HY - Leverage Finance HY- Other

Total

LEHMAN BROTHER.S


Asset Revenue Reduction Impact

7,000 250 7,000 200 4,000 200 4,000 100

22,000 750

12

%

3.6% 2.9% 5.0% 2.5%

3.4°/o

LBEX-DOCID 1401225

Liability Analysis + Brokers have riskier liability structures than banks. For Universal banks this may hide risk in their broker dealers as I

deposits are not accessible to the broker side, but that is largely misunderstood by the market. Our total capital ratio is now > 18%, post convert - although leverage remains high.

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

GECS BAC c JPM

881 Long Term Debt ::::: Short Term Debt I Commercial Paper

GECS BAC Tier 1 Capital ratio n/a 6.9% Total Capital ratio n/a 11.0% Leverage ratio (3) 9.5% 5.0% Moody's Aaa Aa1 S&P AAA AA

LEHMAN BROTHER.S


c 7.1%

10.7% 4.0% Aa3 AA-

WFC GS MER(l) MS(2) SLM(l)

:::: Current Portion of LT Debt 88 Deposits ::: Repurchase Agreements

JPM 8.4%

12.6% 6.0% Aa2 AA-

WFC GS LEH 7.1%

10.7% 3.6%

Al A+

MER MS SLM

13

7.6% n/a n/a n/a n/a 10.7% n/a n/a n/a n/a 6.8% 4.4% 3.4% 3.0% 3.8% Aa1 Aa3 A1 Aa3 Baa2

AA+ AA- A+ AA- BBB-

1. Data as ofNovember 30. 2007. 2. Data as of December 29. 2007. 3. Leverage ratio based on tangible equity capital for GS. MER and MS. shareowner "s equity

for GECS and SLM. and Tier 1 for all others. The leverage ratio is calculated using the average of total assets at the end of2006 and 2007 for GECS. GS. LEH. MER. MS and SLM.

LBEX-DOCID 1401225

Reduction of Refinancing Risk + To reduce refinancing risk, we should consider increasing deposit funded activity/balances and

increasing the deposit base at the bank entities

- Term deposit raising at US banks and Bankhaus

- Use more long term debt (public markets not open for now but as they reopen)

- Long-term bank facilities and commitments

- Term out repos

+ We should use more conservative term structures to fund less liquid securities (EMG, high yield, E2

and E3 equities)

- Higher haircuts on financing

- No short-term (less than a month) repos

+ We should move some businesses currently done in unregulated entities to banks- e.g., customer

margin lending, parts of PB business

+ Finally, we should also seek to diversify asset concentrations and reduce illiquid assets- in part to

address negative market perceptions.

LEHMAN BROTHER.S


14

LBEX-DOCID 1401225

External Constituents - Analysts & Investors

IIIII 1111111111111111111111111111111111111111 111111111-i~~~~~~~~~llllllllllllllll 111111111111111111111111111111111111111

+ Expectation is that there will be de-levering across the

industry

+ LEH and MS most vocal to date about need to, and plan

to, de-lever in current environment

- LEH viewed as having higher concentration of less

liquid assets and need to address these

- GS messaging that they don't believe they need to de

lever (but by growing equity through earnings retention

and keeping assets flat they will likely de-lever a bit as

well)

+ Inevitable that there is a change in regulatory oversight

coming, and de-levering is a likely outcome

+ Capital raise (convertible offering) was positive to get

leverage down quickly

LEHMAN BROTHER.S


15

.........................................................................................

iiiiiiiiiii iiiiiiiiiiiiiiiiiiiiiiiii iiiiiiiiiiiiiiiiiiiii(jfi~~~fisi ::::::::::: ::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::

+Impact on near term earnings and ROE is biggest

concern

- MER estimating a 10-20% reduction in ROE's

- Bernstein estimates ROE's rose 20% since '05

as a result of higher leverage

+Also, investors and analysts want to be comfortable

that this won't impact customer related balance sheet

such that client revenues will also suffer

+Clarity around future regulatory environment

necessary

+Likely one of several capital raises to come across

the industry

+One observation - "Is LEH seeing things in markets

and signaling that additional equity is needed

because environment is getting worse"

LBEX-DOCID 1401225

Documents

Lehman Brothers - Leverage Analysis - Stanford …jbulow/Lehmandocs/docs/DEBTORS...l .. EHMAN BROTHERS April 7, 2008 Erin Callan Lehman Brothers - Leverage Analysis FOIA CONFIDENTIAL